Let me tell you something you already know: The stock market has been in the doldrums for the past three months. It's been depressing, hasn't it? Most any stock you're holding has, at best, gone nowhere and, at worst, gone way down -- for instance, if you own Nasdaq stocks.

So, what's an investor to do, assuming that the market continues to go nowhere? Keep buying stocks and watch your investments stagnate? I have a better idea: Use stock options (the put and call variety) to profit from a stagnating market. Although most people think of options as something used to speculate on big price moves, they can, surprisingly enough, also be used to profit from a lack of price movement. The key is to sell options rather than just buy them as most folks do (more on this later). But first you need to find a solid stock that's going nowhere fast. I think I found such a stock while playing my favorite Xbox game the other day ...

Which stock would that be? Microsoft (NASDAQ:MSFT). The stock is dead money in the short term.

Dead money? Isn't a new computer upgrade cycle on the horizon with Microsoft's impending release of its next-generation operating system for PCs, Windows Vista? Not to mention Office 2007 and Windows Server (codenamed Longhorn)? Yes. Did I forget about Microsoft's very promising Web 2.0 and .NET platform initiatives? Or about its recent decision to buy back 155 million shares from investors via a Dutch self-tender offer for $24.75 each?

Investors punish Microsoft
No. Despite these things, I still feel that Microsoft is dead money over the next four or so months because of residual investor ill-will surrounding the company's disastrous first-quarter earnings report back in late April.

As you may recall, Microsoft dropped a bombshell on the investment community when it revealed its plans to spend an additional -- and unexpected -- $2 billion on vague advertising-related Internet initiatives in its fiscal 2007. The revelation meant the Street's margin and earnings estimates for next year were too high.

This was on top of the company's earlier revelation that its Windows Vista operating system launch would be delayed from November 2006 to January 2007, thus missing the crucial Christmas selling season. The bad news was too much for investors.

The stock tanked 11.3% in a single day, the largest one-day percentage drop in at least five years. The stock has meandered since then and hasn't been helped by the recent prediction of the Gartner research firm that the Vista release will be delayed even past January into the second quarter of 2007.

Microsoft is still dead money
Simply put, this stock ain't going anywhere. The company's $14 billion to $15 billion in sustainable annual free cash flow, its 20% annual earnings growth, and its 20 P/E ratio arguably provides a solid price floor below the stock at right around its current price of $27, but the product delays and uncertainty over the cost-effectiveness of the company's massive new spending plans means it probably won't go up much, either.

Buying the stock now is, in my humble opinion, not an option (pun intended). Why should I shell out, say, $13,500 to buy 500 shares of Microsoft right now if I don't think the stock is going anywhere for at least four months? The $13,500 you invest now could very likely be worth no more than -- you guessed it -- $13,500 in four months.

There's another way -- a better way -- to participate in Microsoft right now, even if you think the stock is going nowhere in the short term. That way, as I alluded to in my intro, is through the use of stock options. And despite the rumors, options aren't as complicated as you may think.

Before you start making zillions (kidding) in options, you'll need to know the basics.

Buying options
Expecting a rise? Buying a call option lets you buy a stock (actually 100 shares of a stock, but I'll employ a per-share focus for simplicity) for a specified "strike" price. You win if the stock rises, but you lose if the stock stays flat or goes down. Fortunately, the most you lose is the price you paid for the option contract -- typically a fraction of the stock price itself.

Expecting a decline? Buying a put option lets you "force" a counterparty to buy a stock from you (you don't have to actually own it at the time you get into the contract). A decline lets you profit off a counterparty's compulsory purchase of a now-depressed stock at its strike price. (Though included for explanation, the actual buying and selling legwork is unnecessary unless you hold until expiration and go through the exercise/assignment process.) Buying a put is the reverse of buying a call: You win if a stock declines but lose what you paid for the option should it stay flat or rise.

Selling options
You don't have to only buy options. You can sell them, too, becoming the counterparty in the above transactions. The worst thing about selling? In selling a call, be prepared to hand over stock at a price less than what it's risen to. Ouch. And when selling a put, you may be forced to pay a high (but agreed-upon) price for a stock now in the toilet.

Buying and selling
With buying options, you win only if the stock moves up (for a call) or down (for a put); you lose (albeit not much) in two out of three price-movement scenarios. But with selling options it's the reverse: You win two ways out of three, but you could lose much more.

Wouldn't it be great if you could combine the limited risk of buying options with the "two out of three" winning percentage of selling options? You can; it's called an option spread. Spreads involve buying one option and selling another of the same variety (calls or puts) simultaneously.

Strike it rich
The magic is in selecting the strike price. Option contracts can be at strike prices at or very close to the current stock price. Those are termed "at-the-money," or ATM.

Call options with strike prices above the current stock price are "out-of-the-money," or OTM. Similarly, puts with strike prices below the current stock price (remember, if you're buying a put you want a stock decline) are also OTM.

Finally, folks may enter into calls at strike prices below the current stock price, or they may try puts at strike prices already above it. These are both "in-the-money," or ITM.

Whew.

So back up and decide how you feel about any stock. The strike price you choose determines whether your spread is bullish, neutral, or bearish.

For a dead-money stock like Microsoft, I'd pick a neutral spread, which involves both an at-the-money option and an OTM option.

Here's how I do it. I sell at-the-money puts that could force me to buy Microsoft at its strike price (which happens to be about the current price) any time in the next four months. With the stock close to $27, I get paid $1.30 per share to take this risk.

I could just do this and sit tight, but I don't like risk. If the stock plummeted, I'd be stuck paying $27 for it, which would leave me angry and frustrated.

So I turn right around and buy a put of my own, albeit a cheaper one. For about $0.45, I can force someone else to buy Microsoft from me at $24.50 a share in those same four months. Now I feel very clever because I pocket the difference of $0.85 per share, or $85 per 100-share contract, if Microsoft stays flat, as I believe it will.

But what if I'm wrong? If Microsoft tanks, the most I can lose is the difference between the two strike prices, against which I can offset the $0.85 per share I pocketed earlier. So, that's $2.50 - $0.85 = $1.65 total. If Microsoft remains dead money at $27 -- or if it rises above that level -- I make $85 (100-share contracts, remember). If it declines a little below $27, I still make $35. If it tanks (something I'm not expecting it to do), I lose up to $165, but no more.

At first glance, $85 on the upside versus $165 on the downside seems like a lopsided deal. But mathematically, you're risking $165 to make (if you're right) $85. That's 52% profit. If I'm right about Microsoft's being dead money in the next four months, 52% is a lot better than the 0% I could make sitting on the sidelines.

Here's a table outlining the profits and losses in greater detail.

Microsoft Short Jan. 27 put/Long Jan. 24.50 put
 (Initiated for a credit of $0.85 per share)

Stock Price
at January Expiration

Profit/
Loss Per Contract
(100 shares)

$30

$85

$27

$85

$26.50

$35

$26.15

$0 (breakeven)

$25

($115)

$24.50

($165)

$20

($165)


The same options strategy can be used for other "dead money" computer stocks, such as Intel (NASDAQ:INTC) and Dell (NASDAQ:DELL), both of which will eventually benefit from the computer upgrade cycle caused by Microsoft Vista but whose stocks are suffering from poor recent earnings reports. Other large-cap stocks with strong long-term fundamentals but that have recently had disappointing earnings or sales and could be considered candidates for a neutral put credit spread include IBM (NYSE:IBM), Dow Chemical (NYSE:DOW); Qualcomm (NASDAQ:QCOM), and Adobe Systems (NASDAQ:ADBE).

Whoever said that a stock needs to go up for you to make money?

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Foolish options guru Jim Fink owns none of the securities mentioned in this article. The Motley Fool has an ironclad disclosure policy.